PD 27 CLIFR Update2008 General Meeting

Assemblée générale 2008Toronto, Ontario

PD 27 CLIFR Update2008 General Meeting

Assemblée générale 2008Toronto, Ontario

Canadian Institute

of Actuaries

Canadian Institute

of Actuaries

L’Institut canadien desactuaires

L’Institut canadien desactuaires

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Valuation of Group Life and Health Policy Liabilities

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AgendaAgenda

• Educational Note• Group Experience Rating Refunds

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BackgroundBackground

• First Educational Note on Group valuation in Nov 2000

• Companion piece to draft Life SOP• Reduced to Research Paper Sep 2001

• Recently revisited by CLIFR• Educational Note to be re-published with

modifications

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FactsFacts

• Varieties in groups and their risks• Employee groups, association, creditor• Size of groups• Industries and occupations

• Varieties in benefit provisions• Many products, variations within products

• Varieties in financial arrangements• Fully pooled, prospectively rated, refund

accounting, hold harmless, ASO, etc.

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Valuation ChallengesValuation Challenges

• Customization• Specific client needs complexity

• Refund accounting• Additional complexity

• Data issues• Policies may be administered by the insurer,

or the client, or a third party• Some contract information may exist but not

available to the valuation actuaries

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What’s in the Educational NoteWhat’s in the Educational Note

• General descriptions• Group business characteristics, benefit

descriptions, financial arrangements

• CALM, term of the liability• Cash flows

• Reported claims, IBNR• Future claims (premium rate guarantees)• Experience rating refunds (ERR)

• Other miscellaneous guidance

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Experience Rating RefundExperience Rating Refund

• Applicable to refund accounting• Policyholder (PH) eligible for refund if

experience better than assumed• Typically one-way: head you win, tail I lose

• Refund to PH similar to income to insurerERR = premium – retention charges – claims +

interest credited – increase in PH reserves

(Income = premium – expenses – claims + investment income – increase in reserves)

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Where Come the Profits?Where Come the Profits?

• Retention charges• Interest spread• Premiums?

• Only if already in deficits, additional premiums could generate profits by recovering past deficit losses

• Pooling charges

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Managing Refund RisksManaging Refund Risks

• Financial arrangement• CFR, cross-rating, hold harmless provisions

alleviate but do not eliminate the risk

• Risk charges• Conservative PH valuation basis• Other management

• Prudent underwriting, effective deficit management practice, pooling charges

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Liabilities for ERRLiabilities for ERR

• Margin returnable to PH• Policy by policy calculation

• John’s win does not offset Joe’s loss• Complex due to varieties in arrangements

• Guidance• No one-size-fits-all approach, always more

peculiarity, exception and variation• Focus on key considerations• Discuss approximations and limitations

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Accrued ERR (retrospective)Accrued ERR (retrospective)

• Refund based on past experience• Calculation reflects terms in agreement

• Expenses, risk and profit charges to be deducted from premiums; interest to be credited; policyholder reserves to be held

• Refundable surplus recorded as liability• Paid out as refund, or used to fund CFR

• Deficit may or may not reduce liability

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Future ERR (prospective)Future ERR (prospective)

• Margins in existing PH reserves• Mort/morb assumptions• Valuation expense• Valuation interest rate

• Margins in future premiums• Premiums to the end of the guarantee period

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Projecting Future ERRProjecting Future ERR

• Not projected on expected basis• Projected experience follows CALM, that is,

with MfAD projected ERR less than what is expected

• PH reserve does not follow GAAP• PH cash flow assumptions expected +

MfAD in CALM• PH valuation expense what is charged• PH valuation interest rate credited rate and

not based on investment return

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Benefit Cash Flows (Mort/Morb)Benefit Cash Flows (Mort/Morb)

• PH valuation benefit cash flows – CALM benefit cash flows (expected + MfAD)

• 0 no contribution to future ERR• +ve may contribute to future ERR• -ve generates future deficits, may reduce

future ERR cash flows from other sources

• Analogy: head you win, but I won’t pay if you still owe me money; tail I lose, but not if I have collateral to draw on.

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Valuation ExpenseValuation Expense

• Expenses charged in calculating ERR based on retention formula in contract

• PH valuation expense ≠ formula• Valuation expense in PH reserve –

expense charge• 0 / +ve / -ve same treatment as for ERR

due to difference in benefit cash flows

• Insurer actual expense has no impact on ERR

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Interest CreditInterest Credit

• Interest crediting often based on GICs• Interest rate used to calculate PH reserve

not tied to crediting basis• Interest credit – interest assumed in PH

reserve• 0 / +ve / -ve same treatment as for ERR

due to difference in benefit cash flows

• Actual investment yield by insurer has no impact on ERR

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Premium MarginsPremium Margins

• Only to the end of rate guarantee period• Premium – retention charges – PH

reserves on future claims• 0 / +ve / -ve same treatment as for ERR

due to difference in benefit cash flows

• A -ve amount alone does not imply premium inadequacy due to presence of strains in PH reserves

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Other Considerations …Other Considerations …

• Project ERR cash flows by duration• Consider effect of accumulated deficit or

CFR at each duration• +ve contributions first reduce deficit before

becoming refund cash flow• -ve contributions … CFR … hold harmless

… increase accumulated deficits

• If policy terminates, cash flows change• Adjust for policy persistency?

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So Complicated?! So Complicated?!

• Does it have to be so complicated? • YES - do this if you can• NO - use of approximation is more

common than not, be sure to understand the limitations

• MAYBE you were using approximation without fully understanding the principles supporting it Evaluate

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A Common ApproximationA Common Approximation

• Approximate future ERR liability (by policy) ≈ (PH reserve – statutory reserve) – PH deficit, subject to zero floor

• Understand the limitations, which are deviations from key principles ( )

• Apply judgment and materiality principles

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QuestionsQuestions

• To all your good questions, here is my answer: “It’s a very good question. I’ll get back to you.”

• Have a good lunch